Market downturns are a value and income investor’s best friend, as sell-offs over the past few days present value investors with another opportunity to pick up their favorite high-yielding names that also have durable dividend track records.
This brings me to Starwood Property Trust (NYSE:STWD), which is now back to yielding above 8% after the recent market rout. In this article, I highlight why STWD is looking attractive for income investors, so let’s get started.
Starwood Property Trust is a diversified finance company that focuses on commercial mortgages, infrastructure lending, and owned real estate. It’s survived multiple real estate cycles since 1991, and is led by long-time Chairman and CEO, Barry Sternlicht. Since inception, STWD has deployed $91.4 billion of capital, and currently manages a portfolio of over $27 billion across debt and equity investments.
STWD is primarily a real estate lending platform that benefits from an experienced management team comprised of 350 employees that leverage Starwood Capital Group’s (the external advisor) 4,000 person organization. This gives STWD a line of sight and deal flow opportunities that it would not otherwise have as a standalone operation.
Since 2014, STWD has diversified its operations from just commercial lending to also owning physical real estate, residential lending, and infrastructure lending. As shown below, commercial lending still comprise the majority of STWD’s portfolio, representing 65% of portfolio value, and 55% of distributable earnings.
Moreover, STWD’s infrastructure segment is comprised of long-lived projects relating to midstream/downstream (36% of infrastructure portfolio), which are not as sensitive to price swings, and natural gas (62% of portfolio), which the world can’t seem to get enough of these days.
Meanwhile, STWD continues to prudently manage its commercial lending portfolio, which is diversified by geo and property type. The loan portfolio is also relatively safe, with a weighted average loan-to-value of 61%, implying that an underlying property with a borrower in default would have to lose 39% of its fair market value before STWD begins to incur losses. As shown below, 91% of STWD’s commercial loans are first mortgage loans that sit at the top of the capital stack.
STWD closed another busy quarter, with $3.8 billion of investment activity including $2.2 billion in commercial lending during the second quarter. The entire $2.2 billion was related to 15 senior loans, all of which were floating rate. This drove STWD’s investment portfolio to a record $27 billion. Also encouraging, STWD’s undepreciated book value increased by an impressive 26% YoY to $21.51.
The loan portfolio appears to be in good shape, as 100% of STWD’s loans are current and the weighted average risk rating improved sequentially from 2.6 to 2.5 at the end of Q2. Moreover, management is growing the company in an accretive manner, issuing 1.4 million shares in the latest reported quarter and an average share price of $23.54, representing a 9% premium to the aforementioned $21.51 NAV per share.
However, STWD isn’t immune to economic uncertainty. With the market seesawing between record unemployment and talks of a recession, management is taking the safe route by increasing its CECL reserve by $8 million to $59 million.
Looking forward, STWD is well-positioned to take advantage of rising rates, especially with the market anticipating another big round of rate hikes. This is reflected by the fact that 99% of STWD’s commercial loans are floating rate. It also maintains modest leverage with an adjusted debt to undepreciated equity ratio of 2.3x, and has $4 billion of unencumbered assets and $9.3 billion of available liquidity under its existing credit lines.
Management emphasized the importance of quality over volume, its growing owned property portfolio, and the benefits it expects to receive from elevated rates, as noted below during the recent conference call:
Executing our plan is less dependent on volume of investments and is more dependent on timing sector rotation, the performance of our credit and staying optimally invested, therefore, not sitting on too much or too little capital. Finally, interest rate sensitivities continue to move in our favor. Rina mentioned our interest rate floors and SOFR is now over 150 basis points above our average floor so we will continue to make more money as rates drive.
And importantly, our new loans will have floors at today’s SOFR levels, which will have a big benefit should SOFR decline in the future faster than the forward curve. Our $3 billion owned property portfolio continues to be our best performing investment, and as Rina mentioned, we wrote up our Florida multifamily valuation, not on cap rate, but based on experienced rent growth, which we expect to continue to rise with median income growth in the future.
Lastly, I find STWD’s 8.2% dividend yield to be attractive at the current price of $23.49, especially as it remains more than fully covered by $0.51 in distributable earnings during Q2. I also find value in the stock, as it trades at just a 9% premium to its undepreciated book value. Sell side analysts have a consensus Buy rating on the stock with an average price target of $27, equating to a potential one-year 23% total return including dividends.
Overall, I like STWD as a high-yield income play that is positioned to benefit from an improving economy in the long run and rising interest rates. Its portfolio is well diversified and prudently managed, and the stock appears to be attractively valued at just a 9% premium to book value with a 8.2% dividend yield. As such, I find STWD to be a smart buy for income investors at present.